Diana Clement: Tax return errors can feel full weight of IRD

Filing tax returns online can help mitigate some mistakes such as common calculation errors. Photo / Thinkstock

Sending off their tax return is cause for a sigh of relief for many Kiwis. That is, unless they've made a mistake, which is when the full weight of the Inland Revenue Department (IRD) can come down on people.

Even genuine mistakes can be costly. If the IRD comes across one the taxpayer is usually charged a penalty and use-of-money interest. If the mistake was made a few years back the interest charges can really add up.

Some of the common tax mistakes New Zealanders make include:

* Failing to maintain accurate records. Private taxpayers and small business owners need to keep records such as proof of income, evidence of expenses, receipts for money they're claiming against income, interest and dividend statements, cheque books, deposit books and bank statements. There are plenty of other reasons to keep good financial records as well. For example, you might want to claim tax rebates on charitable donations. It's important to keep copies of your tax returns for your own records as well.

* Procrastinating. This is one of the worst mistakes when it comes to tax. Putting off till tomorrow what is due today just costs money when it comes to the IRD.

* Not filing because you can't pay. The sooner you file a return the better. If it's filed on time, that is one less penalty to pay. The next step is entering into a payment agreement with the IRD, which is a much better practice than adopting head-in-the-sand-itis.

* Forgetting to return income, interest, or dividends. Unless people have very good record-keeping systems it's easy to forget to include a bit of income here, an interest payment there, or a dividend. Perhaps the dividend is paid out in shares, not by cheque or direct credit. "The IRD has details of those dividends and all interest paid. At some stage [it] will do a matching of the two," says Jo Doolan, tax partner at Ernst & Young.

* Failing to declare cash income. The black economy is alive and well with up to $8 billion a year escaping the clutches of the IRD. The trouble is that not declaring this income is tax evasion, not avoidance, and is a criminal offence. The IRD's systems are becoming more sophisticated, which helps them identify undeclared income. For example, a bakery that fails to ring up sales could have difficulty explaining the amount of raw materials it buys - if the IRD comes calling. The IRD was given additional funding in the May 2010 Budget to take action against those who choose to operate in the hidden economy and has used some of that money to invest in compliance and intelligence tools. The investment has paid off. For example the PAYE payments from the horticultural industry have almost doubled in five years even though the industry itself hasn't grown much at all.

* Mixing business with pleasure. Taxpayers often fail to apportion private and business use of an asset or expenditure correctly. They think they can claim 100 per cent of their car use as business, whereas they use it for private trips as well. Sometimes, says Doolan, they mistakenly feel entitled to claim something because they're working all hours on their business. The IRD doesn't agree.

* Transferring shareholdings to a family trust. This is a real fish-hook that catches lots of small business owners and property investors. The person gets advice or decides off their own bat that their company shares should be in the family trust. The trouble is that once they're transferred, says Doolan, the individual can no longer claim tax losses and imputation credits from their company against their personal taxes.

* Failing to include income from foreign sources on an IR3. Kiwis with money invested overseas need to declare all of those investments in their IR3, says Colin De Freyne, partner at Grant Thornton. That includes investments that are "tax-free" in their country of origin , such as the UK's tax-free Individual Savings Accounts. The IRD does have ways of identifying non-disclosure, such as being aware of credit or debit cards issued by foreign banks to New Zealand residents who may have access to concealed funds in offshore bank accounts. There is a four-year exclusion for newly arriving residents or for Kiwis who have been away for more than 10 years. The IRD has a list of the top 10 international tax errors here: Ird.govt.nz/international/topten/

* Capital expenditure claimed as maintenance and repairs. Often small business owners claim capital expenditure such as a new roof as maintenance, says Doolan. The trouble is that capital expenditure can't be claimed as a business expense in the year it happens. It needs to be depreciated over a number of years. Likewise using incorrect depreciation rates is a common tax mistake. Often property and small business owners depreciate items at the rate they've always done. The trouble is the rules have changed and that many erstwhile depreciable items are no longer depreciable.

* Bad debts written off after the start of the financial year. Bad debts must be written off before the end of the financial year. What's more, when bad debts are written off the business owner needs to make an adjustment for GST, says Doolan. "People forget that the principles that apply to accounting are quite different to the tax rules."

Taxpayers who know in their heart of hearts that they have made a mistake need to make a voluntary disclosure as soon as possible.

The advantage of doing this is that they will not be taken to court and any shortfall penalty will be reduced. Voluntary disclosures can even be made after the IRD has notified you of a pending tax audit or investigation, but before it begins.

The discounts on penalties, however, are greatest for those people who make voluntary disclosures before the notification of pending investigations.

There are a number of voluntary disclosure forms on the IRD's website, including the main IR281 form. The IRD can accept disclosures by using these forms, on the phone, by letter, fax or email, by visiting one of its offices or during an interview.

For anything other than small, genuine mistakes, taxpayers ought to consider coming clean via a tax agent or accountant who can negotiate on their behalf.

There are degrees of seriousness with tax mistakes. At the lower end of the scale are genuine mistakes. The consequences are worse where the taxpayer hasn't taken reasonable care, having an unacceptable tax position, gross carelessness, having an abusive tax position, and at the most serious end of the scale, evasion. The penalties range from 20 per cent of the tax shortfall for genuine mistakes, to 150 per cent for evasion.

Ian Craig, tax partner at BDO, points out that the IRD has the guns loaded in its favour. If you've made a mistake of more than $100 tax to pay you can be charged use of money interest from the day after the money was due up until the date the tax is paid in full.

It might be tempting to fix the problem in the next return, but that isn't necessarily the answer. "Fixing the problem up in the next return does not eliminate the possibility of a shortfall penalty, so although it may seem like a practical solution, it is not without risk," says Craig.

Tax mistakes aren't always in the individual's favour. Sometimes they've paid the IRD too much. Overpaid tax can usually be reclaimed. For example, providing they have invoices and meet certain criteria, taxpayers can lodge amended returns covering unclaimed GST expenditure for up to two years.

Filing tax returns online can help mitigate some mistakes such as common calculation errors. There are built-in calculators for the IR3 and IR4 that crunch the numbers for you.

A list of common property tax mistakes can be found at: ird.govt.nz/property/property-common-mistakes